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On the Optimal Inflation Rate

Author(s): Brunnermeier, Markus K; Sannikov, Yuliy

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Abstract: In our incomplete markets economy households choose portfolios consisting of risky (uninsurable) capital and money. Money is a bubble, it has positive value even though it yields no payoff. The market outcome is constrained Pareto inefficient due to a pecuniary externality. Each individual agent takes the real interest rate as given, while in the aggregate it is driven by the economic growth rate, which in turn depends on individual portfolio decisions. Higher inflation due to higher money growth lowers the real interest rate on money and tilts the portfolio choice towards physical capital investment. Modest inflation boosts growth rate and welfare.
Publication Date: May-2016
Citation: Brunnermeier, Markus K, Sannikov, Yuliy. (2016). On the Optimal Inflation Rate. American Economic Review, 106 (5), 484 - 489. doi:10.1257/aer.p20161076
DOI: doi:10.1257/aer.p20161076
ISSN: 0002-8282
Pages: 484 - 489
Type of Material: Journal Article
Journal/Proceeding Title: American Economic Review
Version: Final published version. Article is made available in OAR by the publisher's permission or policy.

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